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3 Ways to Cut Your IRS Tax Bill

Did you just pay the IRS more than you wanted? Here's how to make it better next year.

Tax season just ended, but many taxpayers are still reeling from the big checks they had to write the IRS. If you're one of them -- or even if you just didn't get as big a refund as you expected -- then now's the time to take a closer look at your taxes and see what you can do to put yourself in a better position next year. In particular, three simple strategies can help you reduce your outstanding taxes, and while they're not all easy, they have other benefits that go well beyond your dealings with the IRS.

1. Take control of your taxable income

No amount of taxes should prevent you from bringing in as much income as you can, but you can still be smart about how much of that income actually gets taxed. The most important way that you can reduce your taxable income is by making contributions to retirement savings accounts. If you have a 401(k) or other employer-sponsored retirement plan at work, then the money you elect to have put in your retirement account never shows up on your W-2 as taxable income in the first place. Those who choose to make deductible IRA contributions report them on their tax returns, and while it doesn't reduce your wage income, it does offset your total earnings in the calculation of adjusted gross income.

Having more money taken out of your paycheck to go toward a 401(k) will reduce your paycheck. But you'll notice that the amount of that reduction is less than what you contribute, because there are also tax savings that get built into how much money gets withheld from your check to go toward taxes. By taking full advantage of retirement savings opportunities, you can get an early start on keeping your taxable income lower.

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2. Get tax breaks for money you're spending anyway

Every year, billions of dollars in tax credits and deductions go unclaimed because people don't know about them. The earned income tax credit is perhaps the highest-profile example of an underutilized tax break, as the IRS estimates that as many as 1 in 5 taxpayers who are eligible for the credit don't actually claim it. In that case, taxpayers are giving up amounts that could be as high as $6,250 for some families.

A variety of credits and deductions cover the various ways that average Americans spend their money. Provisions like the American Opportunity and Lifetime Learning tax credits reward those who have higher-education expenses, while other credits help defray the costs of child care. Deductions for items like moving expenses, state and local taxes, and charitable gifts are often available, but you won't get a tax break if you don't follow the requirements for claiming it. From cost-sharing for renewable energy projects to depreciating home-business equipment and getting government-funded matching contributions for retirement account saving, taxpayers can take advantage of countless tax benefits that can reduce their tax bills.

3. Invest with taxes in mind

Investing presents numerous opportunities for tax planning. Sell a successful stock, and you'll have to pay tax on any gain -- but you might be able to get a tax loss on an unprofitable investment. Buy stocks that pay dividends, and you can often get a lower tax rate on your portfolio income than you'd pay on income from interest-bearing investments. Put a high-growth investment in a Roth IRA, and you'll never have to pay any tax on the gains.

The most valuable tax benefit that you can get in your investments is taking advantage of the huge preferential treatment that the tax laws give long-term buy-and-hold investors. Essentially, you can time when you have to recognize much of your taxable income from your investments, and avoiding selling an appreciated stock can save you thousands in taxes. Combine that with the fact that frequent trading also typically reduces overall returns, and the tax code is doing you a favor by punishing those who only hold their investments for short periods of time.

Tax time is never fun, but if you paid more than you should have in tax this year, now's the time to do something about it going forward. A little tax planning can help ease the pain in 2018 and beyond.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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